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With hedge fund casualties imminent how has Man Group remained unscathed?

Man Group (EMG) 559.5p STOP LOSS 475p

Shares summary

If they are not going out of business hedge funds are grappling with soaring redemptions. But not Man Group which, despite the difficult conditions, continues to expand assets under management and should be a sector winner.

Business:

Hedge fund manager

Vital stats:

Market value: £9,434 million

Historic PE for 2007: 20

Prospective PE for 2008: 12.6

Prospective PE for 2009: 12.5

Sector PE(next 12 months): 12.1

1-month relative strength: -1.4%

1-year relative strength: -2.5%

Yield for 2006: 4%

NMS: n/a

Spread: 1.2%

Some commentators are saying about two thirds of hedge funds will go out of business as a result of the credit crunch. Such as Carlyle Capital Corporation – the now defunct highly leveraged investor in US mortgage backed securities. Or Peloton Partners – they stand to be wiped out as cash-strapped banks ask for their money back. Hedge fund manager Man Group, however, is likely to be a rare winner.

Like the long-only funds, hedge funds are suffering in today’s markets. If they haven’t been under pressure from their bankers, it has been investors demanding their money back with redemption levels spiking. Investors have had good cause to be cautious with some pretty poor performance statistics emerging since the start of 2008.

Index compiler Hedge Fund Research’s (HFR) broad measure of the industry, the HFRX Global Hedge Fund Index, has lost 2.2% between 1 January and 11 April. Meanwhile the HFRI EH: Quantitative Direction index, which tracks the performance of the quantitative ‘black box’ funds, is down 5.7% to 15 April. But the story from Man Group is a different one.

Last month’s pre-close trading update from Man revealed fourth quarter fund sales higher and redemptions lower than expected. Performance was not as good as analysts had hoped for but, in sharp contrast to many of its peers, remained positive. Among the positive performance contributors was the quantitative portfolio Man AHL Diversified which is a key fund for the group.

While we are not told how AHL Diversified performed over the last quarter, analysts at independent broker Landsbanki estimate that it rose by about 11% (Landsbanki has collected historical data for the AHL Diversified Futures fund as a a proxy for AHL Diversified – on 1 January Landbanki says AHL Diversified Futures had a net asset asset value per share of $34.09 per share compared with $37.93 on 7 April).

An 11% rise in AHL Diversified would represent a 16% outperformance versus equivalent funds and performance like this contributed $0.8 billion to the overall $2.3 billion growth in assets under management (AUM) during the period. Of the other $1.5 billion AUM growth, $0.9 billion came from net sales with the residual $0.6 billion due to currency movements.

The $0.9 billion of net sales was thanks to $3.5 billion of new fund inflows over the period versus $2.6 billion worth of redemptions. Redemptions are currently a sore point for the hedge fund industry but the $2.6 billion represents a sharp improvement on the $3.6 billion recorded in the third quarter so, unlike others, Man is going in the right direction.

Both sales and redemptions in the fourth quarter were £200 million better than expected by independent broker Rupak Ghosh at Credit Suisse, although the $0.8 billion addition due to performance was significantly below his expectation of $2 billion-plus(Samir Shah at Landsbanki had expected $1.2 billion). Given AHL has performed so well, questions have been raised over how Man’s other funds did.

Analysts are being conservative with their 2009 numbers with Landsbanki’s Shah predicting a decline in net performance fees from $1 billion this year to $750 million. But this decline should be set in context of $358 million in 2007. 2008 should be seen as an exceptional year for performance fees and set against continued management fee growth as AUM steadily tick upwards.

During March the company launched a new Far East fund raising $1 billion bringing year end AUM to around $75 billion, which is up 4.6% since 31 December’s £71.7 billion. Since then we have also seen an expansion into the US credit market with the acquisition of Ore Hill and, with year end net cash of around $1 billion (Landsbanki estimate) the company has plenty of ammunition to continue acquisitive growth.

The shares have fluctuated between 500p and 600p since the beginning of the year – partly on concerns about its residual stake in its de-merged derivatives broker MF Global – but on 12.5 times, only a slight premium to the sector’s 12.1, Man is being undervalued especially in context of a historical rating of 20 times.